Is AIG Poised To Be Stronger Than Ever?

Insurance titan American International Group, Inc. (NYSE: AIG) has been cleaning up its balance sheet and improving its earnings. The company still trades at a cheap valuation and has been getting rid of non-core assets. The multi-line insurance giant had a great quarter to finish off 2013.

Improving fundamentalsAIG's business trends have been improving. Its book-value-per-share rose 3% to $68.6 in 2013, and book value (excluding other income) stood at $64.28, which has increased for five consecutive quarters. Obviously, AIG still trades at a substantial discount to its book value.

In the last year, its operating income from all three of its insurance divisions including P&C, Life and retirement, and mortgage guaranty saw stellar increases in pre-tax earnings. AIG's direct investment book, which includes it non-derivatives holdings and other portfolio assets and liabilities, saw its pre-tax operating earnings increase to $1.45 billion in 2013. And AIG's global capital markets saw its pre-tax operating earnings increase to $625 million.

AIG holds $21.2 billion in deferred tax assets on its balance sheet, which will shield future taxable earnings. It also reduced its long-term debt by $7 billion, which will translate into an interest expense savings of $350 million. The company's CFO stated that the company will be using a portion of its deferred tax assets in 2014 and 2015.

In 2013, AIG's subsidiaries contributed $8.9 billion in the form of dividends and distributions to the parent company. And the operating companies of AIG are expected to contribute $5 billion to $6 billion in the form of dividends and distributions in 2014.

In addition, the company ramped up its capital returns program to shareholders by increasing its quarterly dividend to $0.125 per share, and increased its share buyback authorization to $1.4 billion. As its return-on-equity increases, the company's share price should follow.

Becoming more focusedIn addition, the company is shedding non-core assets from its balance sheet such as the recent divestiture of ILFC for $5.4 billion to AerCap Holdings (NYSE: AER) . After the transaction closes, AIG will receive $3 billion in cash, and 97.56 million shares of AerCap. AIG will be having a 46% stake in AerCap post-closing, and will account for its stake in AerCap as an equity method investment. And this will make AerCap the largest aircraft leasing company in the world.

And based on huge rally of AerCap after the deal was announced, AIG will have a non-operating gain of roughly $1.75 billion, taking the actual value of the deal to more than $7.1 billion.

AIG took a $265 million severance charge in the last quarter in an effort to make its P&C business more efficient. if AIG can become a better underwriter in its property and casualty business, the company can stellar progress in its business line. Insurance behemoth, Berkshire Hathaway (NYSE: BRK-B) stated in its most recent annual report that its P&C insurance operations have clocked an underwriting profit for 11 consecutive years. And the float used from the insurance operations have been the driving force behind Warren Buffett's empire.

The takeawayThe company's insurance franchises are leaders in their respective categories, and its investment arm is contributing heavily to its bottom line. A large part of the future upside on AIG's stock depends upon its P&C businesses ability to improve its underwriting and control its combined ratio. AIG has a clean balance sheet, and can now return a larger portion of its earnings to shareholders. In addition, AIG still trades at a material discount to book value. There is a very favorable risk reward ratio for AIG at current levels.

Ishfaque Faruk has no position in any stocks mentioned. The Motley Fool recommends American International Group and Berkshire Hathaway. The Motley Fool owns shares of American International Group and Berkshire Hathaway and has the following options: long January 2016 $30 calls on American International Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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